The cash-to-cash cycle across industries

I spent this weekend in Miami (OK, Coral Gables) teaching the core Ops class for an executive MBA section. One of the topics we usually cover in the core (especially with execs) is the cash-to-cash cycle. The cash-to-cash cycle (intuitively) measures how long it takes a firm to capture the gain on its investment in inventory. Mathematically, it consists of days of inventory plus days of accounts receivable minus days of accounts payable. Thus when a firm purchases inventory, it takes a while for those goods to sell. It may then need to wait to collect cash from its customers. However, it may get credit from its suppliers so time in inventory may be offset by the time it has to pay its suppliers. Taken together, these measures give an idea of how effectively a firm uses its working capital. It also may suggest where the firm should target improvement. For example, benchmarking might show that its accounts receivable is out of whack with industry norms so that could be a real opportunity to pursue.

There are a couple interesting things that jump out from this. First, there are some clear differences between industries. Pharmaceutical firms, for example, have a much different cash-to-cash cycle from everyone else. One would guess that this is what happens when, say, you sell a lot of stuff to government entities who take their sweet time paying. Consumer electronics firms, for example, don’t face such problems.

It is also interesting to see how different industries dealt with the recession. Most industries have a pretty significant drop in their cash-to-cash cycles. There are a couple plausible stories that could deliver this result. For one, firms may have aggressively paired inventory. That assumes that they were able to recognize the oncoming slow down quickly and throttle back production — or that they bit the bullet and wrote off a lot of stuff. Note that in most standard inventory models, one finds economies of scale so that higher demand might require an absolute higher amount of inventory but that will represent fewer days of demand. So this story would really be about firms contracting their business — killing product lines or leaving markets in order to weather the storm.

The other possibility is that firms got more aggressive in managing their accounts payable (something we have written about here and here). That would make sense to the extent that these are primarily large firms who would have some power over suppliers.

Obviously both of these could be going on. The accounts payable story could also help explain why cycle times don’t go up for many industries after the recession. Once you find a way to squeeze suppliers, it’s not clear that you have a reason to let go after the economy improves.

That’s all at the industry level. If you look at firms within an industry, you can see that different firms can have very different performance. To start with, looking at consumer electronics, one sees that one of these things is not like the others.

Apple is just different. They get to sit on other people’s money for a long time (i.e., they get their money from selling inventory before they have to pay their suppliers). There are a couple of things happening here. First, they have a lot of retail sales — either physical goods through their own stores or downloads through iTunes. They are not extending credit on those so their receivables is relatively small. Second, their inventory is stunning low (which we have written about before). In a sense, it’s not fair to compare them to Samsung and Panasonic who have a broader portfolio of products and sell in other, non-consumer markets. One suspects that if you looked a Samsung’s handset business in isolation it might look a lot more like Apple.

So consumer electronics firms aren’t necessarily very homogeneous. Car firms should be more similar to each other, right? Not necessarily.

So I must confess that I am at a bit of a loss to explain why there is so much variation in among carmakers. Daimler carries a lot more inventory than most of the other firms (Honda and VW also carry a fair amount). That may reflect longer lead times (since they have less North American production than GM and Ford). It may also reflect a different mix of business since Daimler also makes heavy trucks and competes in some other industrial markets.

The real head scratcher is Ford. Ford’s days of receivables are about three times higher than the industry average. To the extent that the bulk of their sales are going to be to their dealers, it is hard to imagine that they are offering very different terms than any other automaker.